Educational Articles

Should Investors be LinkedIn?

Randy Shrikishun
| June 01, 2011

On May 19th, LinkedIn (LNKD), the online networking site for professionals, held its initial public offering on the New York Stock Exchange. The company and its underwriters issued 7.84 million shares at $45 a share. On its first day of trading, the stock price hit a high of $122.70 and closed at $94.25. The IPO was the largest for an Internet company since Google’s (GOOG) in 2004, and currently LinkedIn is valued at over $8 billion (additional shares were sold in the open market after the IPO).

LinkedIn has over 100 million members in over 200 countries and its services have been used by 73 of the Fortune 100 companies. According to its prospectus, members are able to create, manage, and share their professional identity online, build and engage with their professional network, access shared knowledge and insights, and find business opportunities. Revenues are generated from user subscriptions, advertising sales, and the company’s hiring solutions. In 2010, the top line leaped 101% year over year, to $243 million and LinkedIn reported a profit of $15.4 million, or $0.17 a share on a pro forma basis. Thus, the stock appears to be highly overvalued, with a P/E ratio of over 500, and is trading on the exuberance of investing in the next hottest Internet company rather than on fundamentals.

With almost $30 billion in revenues last year and $8.5 billion in profits, Google’s stock price of currently around $525 a share seems to be justified, given its current P/E ratio of around 18 and a market capitalization of almost $170 billion. At the time of Google’s IPO, its P/E was roughly 245, based on its full-year share earnings for 2003. That said, the company’s bottom line advanced at a solid pace and at the end of 2006, the P/E was 43. Google’s dominant position as a search engine provider, and its business model, which derives revenues through delivering targeted advertising, the licensing of its technology, and from providing solutions to enterprises, seems to be much more sustainable over the long term than LinkedIn’s social networking business. As a result, we believe that LinkedIn has a long way to go before its business model has the same credibility as Google’s even at the latter’s IPO. Even if LinkedIn can achieve healthy earnings and sales growth, investors should be aware of the potential for near-term share price volatility.

For example, the lock-up expiration date for LinkedIn insiders is November 14, 2011. With the sharp appreciation in price in just the first few days of trading there is the possibility of some insiders cashing in after the lock-up date and taking profits. If this were to happen, there may be material downward pressure on shares of LNKD. Trading in the stocks of Internet companies has also been a favored play for speculators and short sellers. The prospect of short sellers pushing the price down, especially given its current high level, is another factor that investors long on the shares should keep in mind.

The LinkedIn offering may signal the beginning of another Internet IPO frenzy, especially given the escalating talks on the Street regarding the possible stock issuances of Facebook, Groupon, Twitter, and Zynga. The LinkedIn deal has tested investors’ appetite for these equities and, from the reaction, there appears to be more than sufficient demand to validate bringing other Internet companies to the market. How long the party will last, remains to be seen though. If LinkedIn’s rich valuation is not supported by the company’s ability to sustain strong earnings growth over the long haul, then the shares are likely to pull back from their current lofty level.

At the time of this article’s writing, the author did not have positions in any of the companies mention.